Discussions about the testing and simulation of mechanical trading systems using historical data and other methods. Trading Blox Customers should post Trading Blox specific questions in the Customer Support forum.

Hi All,
I am now trading continuation systems and would like to add a mean-reverting system to compliment my portfolio. I compare the returns distribution of the two systems below. (pls see attachment)

The red curve is for MR while the green one is for CON systems. Both have positive expectations. You can see that the big chunk of returns is cluttered at small gains level for MR. My question is on exit strategies. Given these two systems, how would you design exit strategies differently.
Exit strategies issues are
1.) Stop-loss
-(Fix or volatility-based)
-(Tight or loose)
2.) Profit-target
-To have or not to have
-Tight-loose
3.) Time-Exit
-To have or not to have
Anyone has experience dealing with MR type systems?

If there was a programmer who worked for you, you could have him program every single one of these ideas and backtest them all - using testing software such as Trading Blox. You could have him repeat these tests on several different portfolios of tradeable instruments, and you could tell him to run the tests with numerous different start-and-end dates of price history.

Maybe "your programmer" == yourself. If so, it will cost you no extra money to have these ideas programmed and thoroughly tested.

My advice would be to firstly rethink exactly what you mean by "mean reverting system".

In my world trading programs fall into 2 categories:

1 Those that make money when price moves
2 Those that make money when price does not move

Type 1 is most common and is about capturing trends in price. E.g. go long something and exit some time later when price has (hopefully) risen.

An example of Type 2 would be to sell some out-of-the-money options and keep the premium when they expire worthless.

Since price is unbounded and unpredictable it does not actually have any kind of mean-reversion tendencies IMHO since the mean is constantly changing. Therefore, most MR strategies are simply Type 1 systems with relatively tight stops and built-in profit targets based on some assumption of average price. In my experience, neither of these techniques is the best way to generate optimal risk-adjusted return.

From a practical point-of-view I'd go with sluggo's advice of testing all your trading ideas to see which works "best" with your chosen instruments and available capital. If you don't have the required skills/time/software either make it a priority to personally acquire them, or pay someone who already has them for their experience and assistance.

Paul King wrote:Therefore, most MR strategies are simply Type 1 systems with relatively tight stops and built-in profit targets based on some assumption of average price. In my experience, neither of these techniques is the best way to generate optimal risk-adjusted return.

In my real world lone trader experience.... Price slippage and broker error/fast markets are the twin grizzly bears in that cave.

Yes, higher implementation costs and under-estimation of volatility while you're in the trade are contributing factors to erratic performance, but the real grizzly bear is basing a trading system on a concept that is really an illusion.

Paul King wrote:Yes, higher implementation costs and under-estimation of volatility while you're in the trade are contributing factors to erratic performance, but the real grizzly bear is basing a trading system on a concept that is really an illusion.